Business outcome pricing will be a critical differentiator for technology vendors
By Angel Dobardziev
15th May 2018
Most IT services contracts today are delivered on either a ‘time and materials’ (T&M) or fixed price arrangements, with T&M historically being the lion’s share of the deals. When a large client, say a telco or a pay TV provider such as BT or Sky, hires an IT Services vendor such as IBM or Wipro for IT systems integration or management work, more often than not it is done in a ‘body shopping’ arrangement (as T&M is typically called in the trade). Fixed price contracts have also grown over the years for system development and integration projects such as implementing new billing or analytics systems, especially those using Waterfall development methodologies.
Neither T&M nor fixed price arrangements have been ideal for enterprises in general, and telecoms and media clients in particular. The instances of major system delays, cost overruns, systems not fit for purpose, IT contract clashes (and derailed careers as a result) are too many to count in the telecoms and media industry and beyond. The core of the problem stems from the fact that T&M and fixed price contracts are inadequate as tools for aligning the strategic needs and incentives of clients with those of IT vendors.
Clients hire IT services vendors for IT system development and management that will ultimately serve to deliver tangible business needs and outcomes, which in today’s ultra-competitive environment are too often changing rapidly. T&M and fixed price deals focus vendors on technology outcomes (if any) – often with little or no sight to client’s ultimate business outcomes, and this is at the core of the misaligned incentives. Business outcome based pricing can change this by aligning IT Services deal incentives to not only the technology outcomes, but also business outcomes clients ultimately aim for.
Let’s bring these concepts to life with an example. Say a pay TV operator decides to restructure its pay TV value proposition having digested the implications of the message in this article. The pay TV operator is soon likely to realise that its billing and analytics systems also need a major redesign to ensure better user segmentation, targeting and billing; so it decides to hire an IT services vendor for the job. Should it sign a T&M based deal for the job, its IT services vendor is paid for the time its consultants and developers spend building the new system features and functionality. This makes T&M flexible, but it can often take a lot more, or longer, than planned; the IT developers have no incentive to rush in a T&M context.
By contrast, with a fixed price deal a client needs to specify all the features and functionality it needs in advance (never easy) and then agree a set price for these with its IT vendor. So the price is capped; but making changes to requirements (which is very common as proposition and/or market needs change) in a fixed price deal is often difficult, costly and time-consuming as a result. Finally, in a business outcome priced deal, the IT vendor’s compensation is tied in some way to the business success (i.e. client/revenue growth) of the new pay TV proposition. The key to success of this arrangement is in the detail: what exactly, how, and how much, of the IT vendor’s compensation is tied to business outcomes, and what, if anything, is done via a T&M and fixed pricing.
The IT services industry has been talking about business outcome-based pricing for over a decade; in fact ever since 2004 when IBM secured its historic deal to run Bharti Airtel’s IT on a share of Airtel’s revenues and subscriber growth. As a result of Airtel’s stunning growth, IBM benefited handsomely from this decade-long deal. (It was renewed in 2014, but on a less generous revenue share). Despite a big push by various vendors and clients for more of it over the last decade, business outcome pricing has so far been only a sprinkle in selected, notably systems and business process management, deals.
One of the key reasons for the muted take up is that business outcome pricing is the risk that comes with it - for both sides: a deal of the original IBM/Airtel variety sends CFOs into nervous fits, as it introduces an enormous uncertainty into the cost/revenues associated with it. A full revenue share deal in effect means taking an equity stake into the client, as its contract income is tied to the client’s business results, although the IT vendor influence on these results is evidently not under its complete control.
Three issues have come into play over the last few years that led me to believe that properly executed business outcome pricing is not only more relevant today, it is actually critical for differentiation among leading IT service vendors. First, business leaders have got lot more involved in IT buying decisions, especially given the wave of digital transformation initiatives: telco CMOs are likely as involved, if not more, as CTOs in the buying and the implementation of a new billing and analytics platform that needs to deliver a single view of the customer. And business leaders increasingly challenge the norm in technology buying by demanding see a more tangible link between systems investment and the business outcomes they are accountable for.
Second, Agile system development methodologies have grown in adoption to the point that they are seen as superior to Waterfall methods that have used the bulk of hitherto system development. Agile methodologies are indeed excellent at delivering on changing client business outcomes – but due to inherent flexibility, speed and agility they seek to deliver, they works better on a T&M basis, rather than fixed price. And finally and perhaps most importantly, we see evidence that telecoms and media clients that are starting to demand business outcome pricing elements in recent IT services RFPs.
What this all means is that top IT Services vendors need to bring business outcome pricing into their strategic IT Services engagement toolkit in order to differentiate from the crowd. That said, it cannot be overemphasised that business outcome pricing is a sharp tool that must be handled with care: sparingly, with a willingness to link a small, but meaningful share (i.e. up to 25%) of the deal revenues to business specific SLAs; used with the most strategic clients only; and as the preserve of leading IT vendors alone. This is not a suitable engagement framework for a small IT staffing agency seeking tactical relationships, nor should it be considered by offshore IT vendor that seeks to differentiate on cost alone.
In essence, business outcome pricing in IT Services engagements is as much about signalling as anything else. By demonstrating preparedness to tie in a small but meaningful fraction of the deal revenues to business SLAs, an IT vendor signals the strategic nature of their relationship to the client. It also signals the IT vendor’s deep industry knowledge and understanding of the client’s business issues that will affect these business centric SLAs (as well as its confidence in its ability to meet them). Most importantly, it signals that it is a top tier IT services vendor; ultimately only such players will have the confidence, resources and risk management tools to include business outcome based SLAs and pricing in the mix
This article was first published at Total Telecom.